25 January 2022

How The Dynamic of Supply Chains and Inventories Could Create a Quick Drop in Inflation This Year

Here's a theory about inflation that you may not have heard. I could be wrong but this theory is based on a lot anecdotal evidence that seems to correlate with broad sets of data.

I've heard clients in Asia, Europe and the US complain about supply chain issues. Recently one told me about an item that used to have a lead time of 4 days that was recently quoted as having a lead time of 56 weeks.

For most of these clients, the price of any one item is of little consequence. They would pay double or quadruple for certain items that might mean the difference between being able to make their product or not. On site at one client making chips for cars years ago, I saw a sign reporting that the average new car has more than 100 chips. You only need a dozen of those chips to get stuck in a supply chain somewhere to delay production of the entire car. If paying more for a chip allows you to make the car, you will pay a lot more for that chip.

The other thing going on is that these folks are hoarding. If the supplies are available, they buy them. If delivery times have gone from 4 days to 4 or 40 weeks, they buy what they can now. And they don't care that much about the cost. The inventory is insurance against future supply chain issues.

To me, it sounds like the old beer game simulation that teachers of systems dynamics would run. In that, a one-time surge in demand in a system with lags could result in wild swings in demand and supply. I suspect something similar has happened here.

In the wake of the disruptions that hit with COVID, businesses are now buying more than ever. That is putting even more strain on supply chains that are working hard to produce more. Inventories are growing faster than sales. What could happen in this dynamic? Orders drop off as dramatically as they surged. People with excess inventory will halt orders.

What happens then? Prices drop.

Smarter people than me (folks like Paul Krugman and Larry Summers and Jason Furman) are arguing that inflation will take more than a year to drop. They're arguing for interest rate hikes to lower demand and thus slow inflation. They could well be right but I would trust them more if they even addressed what I see going on with clients.

ASML is one of the most complex companies you've never heard of. They make it possible to make the increasingly tiny chips that go into thousands of devices. They have a network of 4,000 suppliers. They are an extreme example of what I see everywhere.

25 years ago when I was first working with product development teams, about 10 to 20% of their work was outsourced, done by subcontractors and suppliers. That has doubled and tripled with most of my clients in the last 5+ years. Within the last year or two, I've had two clients who outsource about 90% of their development work. Discussing a subcontractor with one of them, I learned that the subcontractor actually had a subcontractor who was creating the item we were discussing. It's a world of supply chains and given the complexity of products it doesn't take much to disrupt them. Again, to protect against these disruptions they buy more to have inventory on hand, creating a surge in demand that could be a big part of what is driving up prices. To the extent that these various suppliers are ramping up production to meet these increase in demand for companies who are buying 100 for current production AND another 100 to create a bigger inventory to protect themselves against future disruptions, there could be a big drop in demand once companies feel safe enough to stop building up inventory. They might drop off on orders from 200 to 100 or - even worse - drop to ordering 0 and merely working down their inventory. In the first case, inflation would fall a little. In the second, inflation could drop a lot.

Lots of experts predicted there would be small gains in inflation from about 2% to 3 or 4% in this last year. Instead inflation hit 7%. Now experts are predicting persistent inflation in the range of 4.5% to 8% for another year or so. They might be right. They're the experts. But given the weird dynamic I hear in the stories from clients, I wouldn't be surprised to see inflation rates drop as dramatically as they rose in the last year as supply chains catch up or even overrun demand.

24 January 2022

Investing in Children Who Have Shown Poor Judgement in Their Choice of Parents

More resources help.

Hopefully future generations will find it bizarre that we so richly rewarded and so severely punished kids for their choice of parents.

Here a study shows that simply giving mothers $300 a month in the first year of life for their child made a measurable difference in a child's cognitive development.

https://www.nytimes.com/2022/01/24/us/politics/child-tax-credit-brain-function.html

Elon Musk is the world's richest man. Elon Musk's grandpa was a leader of Technocracy Incorporated (TI) in Canada from 1936 to 1941. TI advocated for a world run by experts - engineers and scientists, not politicians - whose technology would solve the world's problems. Elon was immersed in the concepts and practice of seeking and developing technology solutions from before he could remember. He did not choose his grandfather.

Jeff Bezos was the world's richest man a short time ago. His grandfather was one of the founding members of ARPA who developed ARPANET - the obscure computer to computer network that evolved into the Internet. His grandpa also managed federal west coast labs that included Los Alamos and Lawrence Livermore, probably managing more scientists and engineers than anyone else in the world at the time. Jeff spent summers at his grandpa's and cites him as an important mentor. The man who helped to develop the internet and how to manage scientists and engineers was grandfather to a man who became the world's richest by developing a wildly successful internet company by managing a large technical team. Like Musk, Bezos did not choose his grandfather.

Bill Gates was the world's richest man for a long time. His father was a local hero in the Seattle area. For instance, Howard Schultz had an agreement with another Seattle area businessman to manage Starbucks and then buy it at a certain point. The man reneged on the deal. Schultz turned to Bill Gates Sr. for help and 6' 7" Bill Sr, a multi-millionaire and lawyer involved in numerous businesses in the area, marched across the street to browbeat the man who had reneged on his deal with Schultz, a young guy who at the time had little net worth. Thanks to this timely intervention, Schultz is now richer than all but about 200 people on the planet, worth roughly $4 billion. Imagine having Bill Sr. ready and able to intervene on your behalf from the time you were born. Bill Gates did not choose Bill Gates Sr. as his father.

Nor, of course, do babies choose to be born to poor mothers. We spend trillions on nonsense in this world. We can spend a trillion or three investing in the children who didn't show the good judgement to be born to powerful, connected, wealthy, and savvy parents. Partly we should do this because it is the right thing to do for the child, an act of grace towards an innocent new to this world. Partly we should do this because the demarcation between selfish and selfless has dissolved. If children grow up with opportunities closer to what Musk, Bezos and Gates had, we all will live in a world with more and better jobs, products, and wealth. To invest in a child is to invest in the community you are dependent on. It is both terribly selfless and selfish to help a child to realize their potential.


13 January 2022

The Even More Truly Extraordinary Numbers Behind 2021's Truly Extraordinary Jobs Numbers

The BLS reports 2 numbers each month for new jobs. One is a result of household surveys. (Something like going door to door asking, "Did you get a new job last month?") The other - the official number - is a result of surveying firms. (Something like calling up businesses and saying, "Did you hire anyone last month?")

Last month the household surveys suggested 651,000 new jobs yet the official number was 199,000, a difference of 452,000. For the year, the household surveys suggest 356,000 more jobs than the official number.

Last year, we had a record number of new businesses start up. Significantly more. In 2021, 53% more businesses were started than in 2019. Those new businesses don't get surveyed because they're not yet on the list for BLS. [Per Austan Goolsbee]

On top of that, people who start unincorporated businesses aren't counted as having new jobs. They're not employees. So if you leave a job to start a business, you will actually show up as one less employee in the job count. [Per Jason Furman.]

One more item of note. When BLS reports 500,000 new jobs, that is a net number. Every month people quit, retire, get laid off or fired. So a month in which you might report 537,000 new jobs (the average for 2021), you may actually count about 4.5 million new jobs and 4.0 million jobs ended, for a net of 500,000.

Quits were at a record level last year. Compared to the rest of this century, quits are up by about 1.3 million. Per month.

So the economy is creating a record number of net new jobs in spite of the fact that 43 million people quit their job last year. (And that is just through November.)

Last year, the economy created and brought back a total of 6,448,000 jobs. Again, that is net. That shatters the old record (set in 1946, the year after World War 2 ended) by 2.2 million. And it may well prove to be an undercount because the rate of new business formation is up by 50%.

The phrase you are looking for is "strong job market."

07 January 2022

Making Sense of the Monthly Job Numbers (and a little reminder about how blurry is our vision of reality)

Since 1970, there has been only one year that ended with a lower unemployment rate than 2021. That was 2019. In this century, the unemployment rate has been higher than December's 3.9% 90% of the time. So last month's unemployment rate is really good news.

Job creation of 199,000 was absurdly low for December and while the 6.4 million for 2021 is the most jobs created for any year on record, it still leaves us down 3 million jobs from December of 2019. So that's mixed news. We needed a big number for job creation and we got a fairly normal one (by the standards of this century.)

The variability in monthly job creation during the last 2 years has been incredible. We've had a month in which we lost 21 million jobs and another month in which we gained nearly 5 million jobs. In one month. Annual job creation jumps all over the place but 180,000 is pretty typical for a healthy, normal month. Since COVID hit, half the monthly jobs numbers represented a swing of more than 650,000 in one direction or another, so monthly volatility has been about 3 to 4 times what it normally is.

On top of that, there seems to be a lot of noise in the monthly measures.

How many new jobs were created in December?
The consensus expectation was for 450k.
ADP is a private company that tracks monthly changes in private employment. Their count for December was 807k.
BLS's household survey that - well, surveys households - arrived at an estimate of new jobs of 651k.
And the official number from BLS - which surveys employers - shows a gain of just 199k. 
This 199k is the headline number.

It's worth remembering that during the long run of uninterrupted job creation in the aftermath of the 2008 Great Recession, the jobs created in a a normal month was about 200,000. What is often forgotten is that this is a net number. Every month about 2 million people were fired, laid off, quit or retired. And about 2.2 million were hired. So, the net for the month was 200,000 "new jobs" but the fact was that there were millions of new jobs that offset the millions of jobs ended. If your measurement error on the 2.2 million new and 2 million ended jobs is just 5%, and the real net for the month was 200,000, you could double the reported new jobs or erase them. Let me repeat that. With an underlying reality of 200,000 new jobs and a measurement error of 5%, it is possible to report that as anywhere from 0 to 400,000 new jobs. The last 22 months have been so volatile that it's easy to imagine that measurement error has gone up. I don't know what actual measurement error is. I do know that it exists and that's just one reason to be cautious in interpreting numbers from one month - particularly before they've been revised. 

The BLS numbers will be revised twice more over the next two months, as they always are. Pandemic volatility makes it tough to track what is going in this labor force of 162 million Americans. The good news is that we're moving in the right direction. By one measure - the unemployment rate of 3.9% - the job market is already healthy. By another measure - the millions of jobs that we've lost over the last couple of years - the economy is still weak.

As with so much in life, you can choose your narrative. Job creation is strong? Cheer about that or complain about inflation. Unemployment rate is low in December? Cheer about that or complain about the rate of job creation in December.

Lots of early retirements and some long COVID disabilities are possibly depressing the number of folks looking for work, which would explain how the unemployment rate could be so low even while we are still millions of jobs short of where we were 2 years ago. Additionally, there seem to be lots of folks who simply haven't worked out issues like childcare or elder care to be able to work again. And while we're buying more goods than ever before, the service sector still hasn't fully recovered.  You might have better or more interesting theories about what is going on. The most robust theories still await more data, though, data that smooths out the monthly variations that sometimes seem nearly as big as the phenomenon they're measuring.

01 January 2022

How Faith in an Invisible Hand has Made Republican Policies So Dangerous (And Made Biden the 21st Century Economic Repairman)

Caption for picture of regulators with chainsaw and bolt cutters from Jonathan Levy's brilliant Ages of American Capitalism.



"Increased residential mortgage lending was one route to President George W. Bush's promised 'ownership society.' Here, a number of federal regulators and banking representatives take a chain saw and pruning shears to the 'red tape' of government-lending regulations. Lax government oversight contributed to fraudulent lending practices during the 2000s."



How did the gospel of deregulation lead to the Great Recession?

As wages stagnated in the early 2000s, people tapped their homes for loans they used to maintain consumption. This was lightly regulated, lenders assuming that even if borrowers income didn't rise enough to pay the loans, the home prices would rise enough to cover the debt. Lenders bundled home loans as MBSs, mortgage backed securities. Between 2003 and 2007, there were $4 trillion in new MBSs. Then investors leveraged those into CDO (collateralized debt obligation), selling these on largely unregulated markets. Finally, these CDOs were leveraged into CDS - an insurance contract that paid out if the CDO defaulted. CDS were built on CDOs that were built on MBSs that were built atop actual home loans taken out by Americans whose incomes weren't going up but whose home values were.
How precarious were those CDSs at the top of the pyramid resting on the bet of steadily rising home prices? "Between 2004 and 2007, the value of CDS-referenced assets in the world increased from $6.4 billion to $58.2 trillion."

That's trillion. How much is $58 trillion in debt obligation? Global GDP in 2007 was $58 trillion. One type of debt was allowed to spiral into a paper value equal to the world's total GDP.

The crash was spectacular. By the time Obama took office, median household wealth in the US had crashed back to where it had been (adjusted for inflation) in 1969. All the gains during the presidencies of Nixon, Carter, Reagan, Bush 1, Clinton, and Bush 2 erased.



Gains in wealth, income, and jobs are not random. They flow from policy, from a collaboration of private and public sector initiatives.


In his final months in office, when Trump paid little attention to the pandemic that was killing more Americans daily than 9-11 had and instead obsessed over trying to invalidate the election, he essentially left COVID relief initiatives to states. At this point in the pandemic, there was little distinction between quelling the pandemic and reviving the economy. Economic policy was health policy but still he largely downplayed the risks of COVID. For him, the love of unregulated responses neatly aligned with his disdain for management responsibility. Bush's affection for deregulation led to a freefall in capital markets. Trump's affection for management neglect (its own kind of faith in the notion that government interventions were worse than no interventions) led to a freefall in labor markets. Trump is the first president since Herbert Hoover to preside over a drop in the number of Americans employed.




As he came into office nearly a year ago, Biden once again (as when he served as VP under Obama) was tasked with cleaning up a mess left behind by a Republican presidency's disastrous policies. The differences in the performance of capital and labor markets is not random.

Since the start of Carter's presidency, job creation rates under Democratic presidencies has run at 6.5X what it has under Republican presidencies; stock market returns are 3X higher. It might just be that no invisible hand is going to save your economy.